The Closing Bell
10/7/17
I am headed for the beach. Be
back 10/16.
Statistical
Summary
Current Economic Forecast
2016 actual
Real
Growth in Gross Domestic Product 1.6%
Inflation
(revised) 1.6%
Corporate Profits (revised) 4.2%
2017 estimates
(revised)
Real
Growth in Gross Domestic Product -1.25-+0.5%
Inflation +.0.5-1.5%
Corporate
Profits -15-0%
Current Market Forecast
Dow
Jones Industrial Average
Current
Trend (revised):
Short
Term Uptrend 21354-23833
Intermediate Term Uptrend 18978-26309
Long Term Uptrend 5751-24198
2016 Year End Fair Value 12600-12800
2017 Year End Fair Value
13100-13300
Standard
& Poor’s 500
Current
Trend (revised):
Short
Term Uptrend (?) 2492-2767
Intermediate
Term Uptrend 2262-3036
Long
Term Uptrend 905-2763
2016 Year End Fair Value
1560-1580
2017
Year End Fair Value 1620-1640
Percentage
Cash in Our Portfolios
Dividend Growth
Portfolio 59%
High
Yield Portfolio 55%
Aggressive
Growth Portfolio 55%
Economics/Politics
The Trump
economy is providing a marginally higher upward bias to equity valuations. The
data flow this week was decidedly upbeat: above estimates: month to date retail
chain store sales, September light vehicle sales, weekly jobless claims, the
September Markit manufacturing and services PMI’s, August factory orders, the
September ISM manufacturing and nonmanufacturing indices, the August trade
deficit; below estimates: the September ADP private payrolls report and
September employment report; in line with estimates: weekly mortgage and
purchase applications, August/revised July construction spending.
The primary
indicators were also positive though not overwhelmingly so: September light
vehicle sales (+), August (+)/revised July (-) construction spending, August
factory orders (+) and the September employment report (-). The call is positive. Score: in the last 104 weeks, thirty were
positive, fifty-six negative and eighteen neutral.
I would note
that the September light vehicle sales and the September ISM nonmanufacturing
index were blow out numbers on the positive side (while the really poor jobs
report was undoubtedly impacted by Harvey/Irma/Maria). Of course, they could be just a couple of
one-off stats. Or when coupled with the
overall upbeat data, they could be the initial signs that economic growth
really is starting to pick up. Follow
through.
Overseas, numbers
out of Europe (except for the UK), China and Japan were very strong. So there was an eerie similarity with the US
data. To be clear, this may only be
coincidental. Further, it is just one
week of simultaneously, highly positive stats.
Nonetheless, we have to take note.
The global economy may have finally hit the ignition switch.
On the fiscal front,
congress took a concrete step towards tax reform. Not that we are there yet. Plus, if enacted, it could turn out to be
more negative than positive if it is not (near) revenue neutral---and the
consensus seems to be that the debt/deficit is going up.
In addition,
there is a new trade pact with South Korea; and I am assuming it is a positive
for the US economy.
On the monetary
side, most of the news flow centered on speculation over who the next Fed chair
will be; but at this point, there are no facts to work with.
Bottom line: this
week’s US economic stats were very positive.
I caution that this is only one week’s worth of data, hardly a
trend. But given the strength in the
stats, we have to be open to the notion that they could be signaling the long
awaited lift off. The same could be said
for the international data: quite positive though not a trend (except for
Europe).
Longer term, with
the national debt now larger than GDP, I am less confident in my upgrading our
long term secular growth rate assumption by 25 to 50 basis points based on
Trump’s deregulation efforts. In
addition, any further increase in that long term secular economic growth rate assumption
stemming from enactment of the Trump/GOP fiscal policy is also up to question.
Our (new and
improved) forecast:
A now
questionable pick up in the long term secular economic growth rate based on
less government regulation. This hoped
for increase in growth could be further augmented by pro-growth fiscal policies
including repeal of Obamacare and enactment of tax reform and infrastructure
spending; though the odds of that are uncertain. Unfortunately, any expected increase in the
secular rate of economic growth could be rendered moot if tax reform (assuming
its passes) increases the national debt and the deficit.
Short term, the
economy is struggling and will likely continue to do so; though the improving
global economy may at some point have an impact.
The
negatives:
(1)
a vulnerable global banking system.
(2)
fiscal/regulatory policy.
The
major news of the week was congressional action on tax reform. It came in the form of moving the FY2018
budget forward---which is a necessary precursor to tax reform. My opinion remains the same: a [near] revenue
neutral tax form bill that makes the code simpler and fairer will be a plus for
the economy; on the other hand, tax reform the increases the national debt and
deficit would be a negative.
The other newsworthy development was the renegotiation
of the US/South Korea trade agreement. We don’t know the terms yet; but with the
Donald being as adamant about putting the US trade relations with other nations
on a more equitable basis, I have to assume this new treaty is a plus for the
US.
In addition, a Japanese trade representative will be
in the US next week for another round of talks.
Since we haven’t heard the bluster associated with NAFTA, again I am
going to assume that this will end as a positive.
So far, Trump’s objective of renegotiating trade pacts
on more favorable terms to the US seems to be going well.
Finally, the US is about to be awarded another growth
opportunity as Hurricane Nate bears down on the Gulf. While the funds needed to aid any cleanup of these
natural disasters are absolutely necessary, they will still have the negative
macroeconomic impact of adding to an already suffocating national debt.
(3) the
potential negative impact of central bank money printing: The key
point here is that [a] the Fed has inflated bank reserves far beyond any
comparable level in history and [b] while this hasn’t been an economic problem
to date, {i} it still has to withdraw all those reserves from the system
without creating any disruptions---a task that I regularly point out it has
proven inept at in the past and {ii} it has created or is creating asset
bubbles in the stock market as well as in the auto, student and mortgage loan
markets.
The news this
week wasn’t really news. It was the
speculation over who will be the next Fed chair---Yellen seemingly out of the
running. The policy range of the leading
candidates range from dovish to hawkish.
So there appears nothing of informational value at this point.
That said, this
week’s strong dataflow likely ups the odds of a December rate hike.
ECB policy meeting scheduled for next week (short):
You know my
bottom line: when QE starts to unwind, so does the mispricing and misallocation
of assets. That thesis is about to be
tested.
(4) geopolitical
risks: Domestic issues held the
headlines this week, but tensions between the US and North Korea, Iran and
Russia remain high. Add to that the
secession movement in Catalonia that is causing heartburn in Spain at the
moment and could become more widespread if it succeeds.
And this
announcement yesterday afternoon (short):
This story
isn’t over and there remains a decent probability of an unpleasant
outcome.
(5)
economic difficulties around the globe. This week, there were few economic
difficulties. Virtually all the numbers
were coming up roses:
[a] August EU
unemployment was low, the September composite PMI hit a four month high and
September PPI was hotter than expected; September UK construction spending and
manufacturing PMI were below estimates; August German industrial orders were
much better than anticipated,
[b] the
September Japanese large manufacturing index was the highest since 2007,
[c] the
September Chinese manufacturing PMI was the highest since 2012.
This is one
week’s worth of stats; so it is way too soon to be projecting lift off for the
global economy. Certainly, Europe
appears out of the woods; but the Japanese and Chinese data has been far too
erratic of late to draw any conclusions.
Bottom
line: our near term forecast is that the
US economy is stagnate though there is a possibility that the improved
regulatory outlook and a now growing EU economy may be stimulative. This week’s numbers are certainly a hopeful
sign. Further, if Trump/GOP were to pull off a
(near) revenue neutral healthcare reform, tax reform and infrastructure
spending on a reasonably timely basis, I would suspect that sentiment driven
increases in business and consumer spending would return.
To be sure,
Trump’s drive for deregulation and improved bureaucratic efficiency is and will
remain a plus. As you know, I inched up
my estimate of the long term secular growth rate of the economy because of it. But I fear that thesis is about to be tested
if the congress passes non-revenue neutral tax reform---however, simpler and
fairer it may be.
The
Market-Disciplined Investing
Technical
Yes, Virginia
stocks (DJIA 22773, S&P 2549) can go down---but not by much. Volume was down and breadth weakened. Both remain above their 100 and 200 day
moving averages and are in uptrends across all time frames.
The VIX (9.7)
was up 5%, ending below the upper boundary of its short term downtrend, below
its 100 and 200 day moving averages, below the lower boundary of its long term
trading range for an eighth day; but it is still above its July low.
The long
Treasury declined, but finished above (but nearing) its 200 day moving average
(support) and the lower boundaries of its short term trading range and its long
term uptrend. However, it is below its
100 day (now resistance) and is developing a very short term downtrend.
The dollar fell,
remaining in its short term downtrend and below its 100 and 200 day moving
averages. It is developing a very short
term uptrend.
GLD rose,
finishing back above its 100 moving average (negating Thursday’s break), above
its 200 day moving averages (support) and the lower boundary of a short term
uptrend. However, it is developing a
very short term downtrend.
Bottom line: long term, the indices remain
strong viz a viz their moving averages and uptrends across all timeframes.
Short term, they are above the resistance level marked by their August highs,
meaning that there is no resistance between current price levels and the upper
boundaries of the Averages long term uptrends.
Trading in TLT,
UUP and GLD was inconsistent.
I remain
uncomfortable with the overall technical picture.
Fundamental-A
Dividend Growth Investment Strategy
The DJIA and the
S&P are well above ‘Fair Value’ (as calculated by our Valuation Model). However, ‘Fair Value’ could be rising based
on a new set of regulatory policies which could lead to improvement in the
historically low long term secular growth rate of the economy (depending on the
validity of Reinhart/Rogoff); but it still reflects the elements of a botched
Fed transition from easy to tight money and a ‘muddle through’ scenario in Japan
and China.
This week’s data
notwithstanding, the US economic stats continue to reflect sluggish to little
growth---although those numbers could be a hopeful sign of lift off. However, much more of the same is needed to
justify such a call. Nevertheless, it
would appear that investors are willing to make, or at least begin to make, the
bet that the economic growth rate will soon pick up. I think that if equities were more reasonably
priced that would make sense. However, with
stocks at all-time high valuations, a little caution seems appropriate.
On the fiscal
front, congress is toiling in the trenches to pass a budget bill which is a
precursor to tax reform. While the
former seems likely out of pure necessity, the latter remains in question,
Street euphoria notwithstanding. That
said even if the current tax reform bill passed in its present form, it will
raise the deficit/debt. To be sure, a
simpler, fairer (?) tax code is a plus and may add marginally to the secular
growth rate. However, I remain convinced
that, given the magnitude of the current national debt, the present proposal
will not provide the impetus to economic growth many hope for.
As a result,
even if passage is achieved, I believe that Street estimates for economic and
corporate profit growth are too optimistic based on the improving economy,
fiscal reform narrative. And when it
wakes up from this fairy tale that could, in turn, lead to declining growth
expectations as well as valuations.
That said,
fiscal policy is a distant second where it comes to Market impact. The 800 pound gorilla for equity valuations
is central bank monetary policy based on the thesis that (1) QE did little to
help the economy but led to extreme distortions in asset pricing and allocation
and (2) hence, its unwinding will do little to hurt the economy but much to
equities as the severe perversion of security valuations is undone.
That thesis is
about to get tested with the Fed announcing the unwind of its balance sheet and
other central banks are making noises like they could follow suit. That said, the appointment of a new Fed chair
could impact this process, perhaps either accelerating the unwind or slowing it
down depending on which candidate is selected.
Bottom line: the
assumptions on long term secular growth in our Economic Model may be beginning
to improve as we learn about the new regulatory policies and their
magnitude. Plus, there is a ray of hope
that fiscal policy could further increase that growth assumption though its
timing and magnitude are unknown. On the
other hand, we don’t know if the size of the national debt would negate any
potential positive. In any case, I continue to believe that the current Street
narrative is overly optimistic---which means Street models will ultimately will
have to lower their consensus of Fair Value for equities.
Our Valuation
Model assumptions may be changing depending on the aforementioned economic
tradeoffs impacting our Economic Model.
However, even if tax reform proves to be a positive, the math in our
Valuation Model still shows that equities are way overpriced.
As a long term investor, with
equity valuations at historical highs, I would want to own cash in my Portfolio
and would use the current price strength to sell a portion of your winners and
all of your losers.
DJIA S&P
Current 2017 Year End Fair Value*
13200 1630
Fair Value as of 10/31/17 13116
1620
Close this week 22773
2549
Over Valuation vs. 10/31
55%overvalued 20329 2511
60%overvalued 20985 2592
65%overvalued 21641
2673
70%overvalued 22297 2754
* Just a reminder that the Year
End Fair Value number is based on the long term secular growth of the earning
power of productive capacity of the US
economy not the near term cyclical
influences. The model is now accounting
for somewhat below average secular growth for the next 3 to 5 years.
The Portfolios and Buy Lists are
up to date.
Steve Cook received his education
in investments from Harvard, where he earned an MBA, New York University, where
he did post graduate work in economics and financial analysis and the CFA
Institute, where he earned the Chartered Financial Analysts designation in
1973. His 47 years of investment
experience includes institutional portfolio management at Scudder. Stevens and
Clark and Bear Stearns, managing a risk arbitrage hedge fund and an investment
banking boutique specializing in funding second stage private companies. Through his involvement with Strategic Stock
Investments, Steve hopes that his experience can help other investors build
their wealth while avoiding tough lessons that he learned the hard way.
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